The Reserve Bank of India (‘RBI’) recently issued the Master Directions on Foreign Investment in India (‘Master Directions’) on January 4, 2018, on the heels of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘New FEMA 20’) issued by way ofNotification dated November 7, 2017, which replace the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (‘Erstwhile FEMA 20’) and the Foreign Exchange Management (Investments in Firms of Proprietary Concerns in India) Regulations, 2000.

The New FEMA 20 and the Master Directions now contain comprehensive rules on foreign investment in India as issued by the RBI. A summary of some of the key changes to the Erstwhile FEMA 20 introduced by the RBI are set out below:

i. Definition of ‘Capital Instruments’: The New FEMA 20 has introduced a definition of ‘Capital Instruments’[1]. While the base definition remains similar to that of ‘Capital’ under the Erstwhile FEMA 20, two clarifications have been provided as follows:-

(a) Non-convertible/ optionally convertible/ partially convertible preference shares issued up to April 30, 2007, as well as optionally convertible/ partially convertible debentures issued up to June 7, 2007 will be considered to be capital instruments till their original maturity; and

(b) Share warrants can be issued to a person resident outside India only in accordance with the regulations issued by the Securities and Exchange Board of India (i.e. the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009), i.e. share warrants can be issued to a person resident outside India only by a listed Indian company.

ii. Definition of ‘Foreign Investment’: ‘Foreign investment’[2] has been defined under the New FEMA 20 to mean any investment by a person resident outside India in the capital instruments of an Indian company or in the capital of a limited liability partnership (‘LLP’), on a repatriable basis; thereby clarifying that investments made on a non-repatriable basis are to be treated as domestic investments and not included in the foreign investment limits.

iii. Definition of ‘Foreign Direct Investment’: The definition of ‘foreign direct investment’[3] (‘FDI’) under the New FEMA 20 distinguishes between investments in unlisted and listed Indian companies. While any investment by a person resident outside India in the capital instruments issued by an unlisted Indian company is to be treated as FDI, in case of listed Indian companies, only investments of 10% or more of the post issue paid-up equity capital of a listed Indian company, computed on a fully diluted basis, is to be treated as FDI.

iv. New Concept – Foreign Portfolio Investment: Under New FEMA 20, RBI has introduced a new concept of an investment being categorized as ‘Foreign Portfolio Investment’ if the investment made by a person resident outside India in a listed Indian company is less than 10% of the post issue paid-up equity share capital (on a fully diluted basis) of such listed Indian company or less than 10% of the paid up value of each series of capital instruments of such listed Indian company.[4] Please note that there a distinction between foreign portfolio investment and investment by an entity registered with SEBI as a foreign portfolio investor (‘FPI’). All investments by each FPI will necessarily be foreign portfolio investment, whereas investment by entities who are not registered as FPI can also be categorized as ‘foreign portfolio investment’ depending upon the percentage of investment made. Purchase / sale of capital instruments of listed Indian company on a stock exchange by FPIs is set out in Schedule 2 of the New FEMA 20.

Foreign portfolio investment by way of a primary subscription is exempt from the reporting requirements prescribed in respect of FDI transactions. In the event foreign portfolio investment exceeds the 10% limit, such investment will stand re-classified as FDI. However, on the other hand, in the event an existing investment by a non resident in a listed Indian company falls to a level below 10% of such company’s post issue paid up equity capital (on a fully diluted basis), such investment will continue to be treated as FDI.

v. Definition of ‘Indian entity’: The tern Indian entity has been defined to mean an Indian company and an LLP.[5]

vi. Definition of ‘Investment Vehicle’: The Master Directions clarify that venture capital funds established in the form of a trust, company or a body corporate and registered under the SEBI (Venture Capital Funds) Regulations, 1996 will not be considered as investment vehicles for the purposes of the New FEMA 20.[6] Prior Government approval would be required for making foreign investments in venture capital funds established as trusts.

vii. Definition of ‘Listed Indian Company’: Listed Indian Company has been defined to mean an Indian company which has any of its capital instruments listed on a recognized stock exchange in India.[7] Accordingly, an Indian company which has only its non-convertible debentures listed on a stock exchange would not be considered as a Listed Indian Company.

viii. Acquisition through a rights or bonus issue: While the conditions relating to acquisition of capital instruments (other than warrants) by way of rights or bonus issue continue to remain the same, it have been clarified that the conditions would also apply to subscription to capital instruments issued as a rights issue that are renounced by the person(s) to whom they were offered.[8]

Further, a person resident outside India exercising any rights in respect of capital instruments issued when he / she was resident in India, can exercise such rights on a non-repatriation basis (i.e. the original status of the holding will not change even in the event the residential status of the holder changes).[9]

Similarly, an individual resident outside India exercising an option granted pursuant to an employee stock option scheme when he / she was resident in India, can hold the shares so acquired on exercising the option on a non-repatriation basis.[10]

ix.Transfer of capital instruments: Transfer by way of sale of capital instruments by a non-resident Indian (‘NRI’) to non-residents other than NRIs no longer requires prior RBI approval, subject to certain conditions.

x. Reporting Requirements: The onus of filing Form FC-TRS for transfers on a recognized stock exchange will now vest with the non-resident party and not the relevant Indian company.[11] The New FEMA 20 has further clarified that in case of transfer of repatriable capital instruments by a non-resident transferor to another non-resident transferee on non-repatriable basis, the onus of such filing would vest with resident transferor / transferee or the non-resident holding capital instruments on a non-repatriable basis, as the case may be. It is also clarified that a transfer of capital instruments between a non- resident transferor holding such instruments on non-repatriable basis and a resident transferee would not attract such a reporting requirement.[12]

Further, Form FC-TRS is now required to be filed with the authorised dealer bank with 60 days of transfer of capital instruments or receipt / remittance of funds, whichever is earlier.[13]

xi. Downstream investments: While the definition of ‘downstream investments’ under the Erstwhile FEMA 20 only considered indirect foreign investments by one Indian company into another Indian company, the definition has now been revised to include investments by Indian companies, LLPs or investment vehicles (each, an Indian entity), in the capital instruments or the capital (as the case may be), of another Indian company or LLP.[14] Further, downstream investments are now required to be reported by way of a Form DI within 30 days of such investment to the Secretariat for Industrial Assistance, Department of Industrial Promotion. However, the format of this Form DI is yet to be specified by the RBI.[15]      

xii. Clarifications regarding reporting and pricing guidelines: In addition to the above, the New FEMA 20 has further clarified that capital instruments of any Indian company held by another Indian company which is not owned and not controlled by resident Indians or is owned and controlled by persons resident outside India (‘FOCC’), can be transferred to:[16]

(a)   a person resident outside India without any requirement to adhere to pricing guidelines, provided however such transfer is reported by way of Form FC-TRS;

(b) a person resident in India, subject to adherence with pricing guidelines only; and

(c) another FOCC, without any requirement to adhere to pricing guidelines or to the reporting requirements.

xiii. Rate of dividend on preference shares: Under the New FEMA 20, the ceiling limit of 300 basis points over the prime lending rate of State Bank of India on the rate of dividend on preference shares or convertible preference shares issued under the said regulations has been done away with.

xiv. Alignment with the provisions of Companies Act, 2013: In addition to the above, the New FEMA 20 has attempted to align several provisions with those of the Companies Act, 2013, in order to address ambiguities that existed under the Erstwhile FEMA 20. A few of such alignments include:

(a) the definitions of ‘employees’ stock option’ and ‘sweat equity shares’  have been aligned with the corresponding definitions under the Companies Act, 2013; and

(b) timeframe for allotment of capital instruments has been reduced from 180 days to 60 days.

xv. Late submission fee for delayed filings: The New FEMA 20 states that delay in complying with reporting requirements (including Forms FC-GPR and FC-TRS) will now attract late submission fee (‘LSF’) of such amount as may be determined by the RBI in consultation with the Central Government. Paragraph 12 of Part IV of the Master Direction on Reporting under Foreign Exchange Management Act, 1999 provides for the quantum of LSF for regularizing reporting delays without undergoing the compounding procedure as under:

            The LSF shall be applicable for the transactions undertaken on or after November 7, 2017.

xvi. New forms to be filed:

(a) A Indian company issuing employee stock option to, inter-alia, persons resident outside India who are its employees / directors, is required to submit Form –ESOP within 30 days of such issuance.[17]

(b) An LLP receiving amount of consideration for capital consideration and acquisition of profits shall submit Form LLP (I) within 30 days of receipt of amount of consideration.[18]

(c) The divestment of capital contribution between a resident and non-resident in case of an LLP shall be reported in Form LLP (II) to the authorised dealer within 60 days from the date of receipt of funds.[19]

(d) An Indian start-up company issuing Convertible Notes to a person resident outside India shall report such inflows to authorised dealer bank in Form CN within 30 days of such issue.[20]